Help with DCF Valuation
Hi,
I am working as a valuations analyst and I recently started. I am having a lot of trouble understanding the connection between the WACC, IRR, and future cash flows of a company and how it all ties together. For example, how do I know if my discount rate is too high or too low? For example, is a WACC of 16% too high? If so, how do i fix it? I am also confused about whether my IRR is too high or too low. I know they want us to make sure the WACC and the IRR are pretty similar to reconcile the purchase? Not sure, but would appreciate any guidance.
The WACC depends on the capital structure and the beta of the industry. Generally more leveraged companies will have a lower WACC, but situation with high leverage will results in a higher WACC due to high cost of equity and the added premiums to the cost of debt (bankruptcy). The IRR is different and is generally used in an LBO. It takes into consideration the initial amount you pay, the FCF for the years before you exit and the amount you receive when you exit the investment. The LBO depends on the leverage (capital structure) but not on the beta of the industry directly, as it depends only on the FCFs (it is true that you have to take into consideration that the cost of debt will be dependent on the industry and other factors but you just need the FCFs to compute the IRR)
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